What to Know About Buying Rental Properties

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Well, here we are, heading in to the end of January, and not much has changed in the marketplace since my newsletter last December. Inventory is still extremely low and the banks still have yet to announce a real plan for disposing of the estimated 1.6 million homes already in default that are set to hit the market (according to Core Logic). This has created an artificial short-term boost in home prices, due to simple economic supply and demand principles.

So since there isn’t much to update you on, I’m going to jump right into today’s topic – rental property.

Navigating all of these foreclosure markets has left most people confused about the best place to buy rental property. The following are some of the questions I’ve been seeing that prompted me to write this post:

  • Las Vegas is currently the largest foreclosure market in the country, and prices are so low that they don’t seem right! Is this the right place to buy and hold?
  • I want to buy in San Diego, but the returns just don’t make sense in comparison to buying out of state. Should I buy multi-units (for example, a duplex, tri-plex or four-plex) to compensate??
  • Downtown condos are so cheap right now, but how do I know if this is a good place to buy a rental?

The core issue that people have is that they often focus only on the price of the home and the rate of rental return or “cash flow” – not the quality of tenant.

Back in 2005, I was probably the biggest victim of this mentality when I purchased a 2,000 square foot tri-plex in Buffalo, NY for just $12,000. Yes, you heard me right – $12,000… The property needed about $20,000 in work, but properties in this area were renting for approximately $300/month a unit! Even with the extra renovations, talk about a return on investment!

On the day the first tenant moved into the property, a shooting occurred in the neighborhood and the tenant vacated immediately – not a promising start! The second tenant I got trashed the unit and was always either short on rent or behind in payments. This story goes on, but I think you get the picture!

The moral of the story here is that you must do your due diligence on the area surrounding your rental property.  For example, what is the job market like in the area? Is the area economically stable?  If all the jobs in your area are dependent on a single employer, or if your chosen neighborhood has high crime statistics, think twice about buying property in the area.

Next up, the question on buying multi-units to increase rental revenue.

My feeling on multi-unit properties is they can be a great investment, but only when purchased at the right price, in the right area. In comparison to a single family residence, however, tenants in multi-unit properties lack the “pride of ownership” felt by single family home residents.

For this reason, you’ll see far more turnover in an apartment complex then on a single family home. You’ll also find that tenants take better care of your single family homes than your multi-unit properties.  I’ve had far more success with my single family rental properties, as excessive turnover and damage leads to extra expenses and creates lapses in your lease periods (costing you even more money…).

Finally, with regards to downtown condos, my advice is the same as with buying multi-unit rental properties. If you can get the units for the right price and in the right locations, they can also be a great investment. However, when it comes to condos in general, I like to stay away from them as rental properties.

Here’s why:

  • When you own a condo, you must pay a higher homeowners’ association (HOA) insurance premium then with a single family home
  • Almost all lenders require what is called an “HOA Certification” to verify the type of occupancy (“owner occupied” or “rental”) in a condo complex. If a high percentage of your neighbors have already converted their units into rentals, it will be much harder for your buyer to get financing when you go to sell.
  • The HOA can go bankrupt, putting your investment at risk.
  • You can pay your mortgage on-time for years, but if your neighbors foreclose, this will tremendously affect your value and your buyer’s ability to get financing.

Are there times when buying condos makes sense?  Absolutely, but be sure you’re going into these deals with a good awareness of the risks and rewards associated with condo rental properties